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Futures: Types of contracts

Depending on the type of underlying asset, there are different types of futures contract available for trading. They are –

Individual stock futures.

Stock index futures.

Commodity futures.

Currency futures.

Interest rate futures.

INDIVIDUAL STOCK FUTURES

Individual stock futures are the simplest of all derivative instruments. Stock futures were officially introduced in India on 9th November 2001. Before that, the local version of stock futures called ‘badla’ were traded which was eventually banned by the Securities Exchange Board of India in July 2001.

The Badla system: the ‘badla system’ was almost similar to the futures contracts we discussed. In simple terms- A badla trader can delay the settlement of a trade by one week for payment of a small fee. So if you bought a particular share for Rs 100 and if you are bullish on that stock, you can delay the settlement by one week if you pay a fee. This carry over can be done for any number of times. Later on, unlimited carry over facility was restricted to 90 days at a time.

Badla system had its downsides – lack of transparency, data regarding volume, rates of badla charges, open positions etc were not available. There was no margin requirement and badla charges varied from seller to seller. So, chances of manipulation were more. Badla was pure Indian version of futures but did not provide the advantages of price discovery or risk management that organized futures market provide.

STOCK INDEX FUTURES.

Understanding stock index futures is quite simple if you have understood individual stock futures. Here the underlying asset is the stock index. For example – the S&P CNX Nifty popularly called the ‘nifty futures’. Stock index futures are more useful when speculating on the general direction of the market rather than the direction of a particular stock. It can also be used to hedge and protect a portfolio of shares. So here, the price movement of an index is tracked and speculated. One more point to note here is that, although stock index is traded as an asset, it cannot be delivered to a buyer. Hence, it is always cash settled.

Both individual stock futures and index futures are traded in the NSE.

COMMODITY FUTURES

It’s the same as individual stock futures. The underlying asset however would be a commodity like gold or silver. In India, Commodity futures are mainly traded in two exchanges – 1. MCX (Multi commodity exchange) and NCDEX (National commodities and derivatives exchange). Unlike stock market futures where a lot of parameters are measured, the commodity market is predominantly driven by demand and supply.

Interest rate futures are traded on the NSC. These are futures based on interest rates. In India, interest rates futures were introduced on August 31, 2009.The logic of underlying asset is the same as we saw in commodity or stock futures – in this case , the underlying asset would be a debt obligation – debts that move in value according to changes in interest rates (generally government bonds). Companies, banks, foreign institutional investors, non-resident Indian and retail investors can trade in interest rate futures. Buying an interest rate futures contract will allow the buyer to lock in a future investment rate.

FROM WEATHER TO TERROR..!!

Weather influences everyone’s lives. Right from daily lives to agriculture to corporate earnings – everything gets affected if the weather is not favorable. For example – let’s assume that this year cold winter is expected in most parts of the United States. What happens is that the price of heating oil goes up. Heating oil futures are traded in commodity markets depending on weather forecasts.

The fear of terrorist strikes had even made Pentagon think of creating a futures market to help predict terrorist strikes. Their theory was that ‘possibility of terror strikes’ in a particular area – for example possibility of a terror strike in New York would be traded as if it was a commodity. Higher the price, higher the possibilities of a terror strike. This way they thought, would help them in finding potential threats.

Or take another example – the ‘assassination of Israel prime minister futures’ which would be available for trade as a commodity. Higher the price, the more likely the event.

However the attempt was scrapped by pentagon in the initial stages itself.

About Jins Victor

Jins Victor is the founder of www.sharemarketschool.com, a website for share market enthusiasts. Based in Kochi, he heads one of the leading financial consultancy firms in Kerala. He is an avid follower of stock markets and invests in his own account. Through this website, he shares his experiences and knowledge and teaches how to make money from share markets using solid rules.

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